Countries heavily dependent on exporting manufactured goods must deny their own citizens higher standard of living to maintain their trade surplus in an era of global wage arbitrage.

Japan, China, and Germany have racked up sizable trade surpluses with the US among producers of manufactured goods (suite101.com 2/1/2008. See Less than Meets the Eye) in recent years. In mercantilist terms, these countries seem to be winning the trade game vs the US.

But unlike the days when gold was the international reserve currency, Japan, China and Germany did not get an influx of gold as payments for their net exports to the US. Instead, these countries ended up with US dollars. Now gold supply is limited by niggardly nature, but the supply of US dollars is limited only by how long the US money printing press is kept running. Why would net exporting countries be willing to accept seemingly endless amounts of US dollars?

Under fiat-money systems, every country is free to print as much sovereign money as it wants. Since the US dollar is a reserve currency, some reserves of US dollars might stabilize domestic currencies. But the amount of US dollar reserves in many export-dependent countries is much too large for this purpose.

The way US dollars become official reserves illustrates how trade surpluses are as much a trap as a mercantilist victory for the net exporters. To pay for the net exports say from China, US importers must buy Chinese yuan with US dollars. This demand would drive up the exchange rate of yuan. Higher yuan value means that Chinese goods would be more expensive and less demanded by US consumers. To keep the yuan value from rising and choking off its export machines, China’s central bank must buy up the US dollars with Chinese yuan. But that runs the risk of inflating the Chinese economy because the goods that match the US payments have been exported. Domestic inflation in turn would drive up the export prices of Chinese goods to US consumers. So China’s treasury must sterilize the newly created yuan by selling bonds to the Chinese holders of yuan. One major way to spend the extra yuan without driving up export prices was to create real estate bubbles domestically (see Bubble Economics).

In other words, to maintain the trade surplus, China must keep domestic wages from rising too fast and keep domestic consumption low (see Dividing the Pie). Instead of trade surplus being a means to improve the standard of living of its people, trade surplus becomes an end in itself. When its central bank reserves are used to buy US Treasury bonds, they lower the interest costs of debts to US consumers and the US government. And when the US dollar eventually devalues vs the Chinese yuan, the value of China’s central bank holdings of Treasury bonds will suffer heavy capital losses. Ultimately, China’s trade surplus ends up being a big subsidy to the profligacy of US consumers and the US government.

Unlike China, Japan and Germany allowed their currencies to float against their trading partners. But to maintain their trade surpluses, they too must contain their export prices by clamping down on domestic wages (see Dividing the Pie). Japan lowered its labor cost by hiring more part-time and temporary workers who represented now 33.4% of its labor force (WSJ 1/16/2007). Germany has resorted to outsourcing its manufacturing to low-wage Central and Eastern European countries to keep its domestic labor market weak (southcentre.org 2010).

Countries like China, Japan and Germany faced similar trade-surplus traps because they are heavily dependent on manufacturing export to fuel its GDP growth. For example, the share of GDP attributed to exports is 33% for China, 50% for Japan and 140% for Germany during 2002-2007 (southcentre.org 2010). If they could pay their workers more to encourage higher domestic consumption, the trade surplus trap would be less tight. But as long as the process of global wage arbitrage continues (see Too Global to Be National), there is not much room for unilateral wage increases.